international economics -some violations of h-o assumptions

8/8/2019 International Economics -Some Violations of H-O Assumptions

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Chapter 8 continued

some violations of H-O

assumptions


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More Chapter 8 topics

When HO cannot predict trade flows:

demand intensity reversal

factor intensity reversal no perfect competition (deserves own section)

Monopoly trade models

Effect of immobile capital (next class)


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H-O predictions

H-O states that the basis for trade isfactor abundance, therefore countries willexport goods that use their abundant

factor intensively and import goods thatuse their scarce factor intensively.

H-O also predicts that the abundant factor

will benefit from trade and the scarcefactor will lose.

This doesnt always work


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Demand intensity reversal

The first case where this is violated iswhen countries have a strong taste for thegood that they should be exporting.

Given two countries

if both countries really really prefer the goodwhose production intensively uses their

abundant factor (relative to the other good), then they may import the good produced by

their abundant factor


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Cloth Cloth

Steel

Steel

Country 1 is capital

abundant but likes steel

Pc/Ps low in autarky

Country 2 is labour abundant

but likes cloth. Pc/Ps is high in

autarky

with trade, Pc/Ps rises in country 1 and falls in country 2.


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Cloth Cloth

Steel

Steel

Country 1 is capital

abundant but likes steel

Pc/Ps low in autarky

Country 2 is labour abundant

but likes cloth. Pc/Ps is high in

autarky

with trade, country 1 exports cloth and country 2 exports steel.


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Factor intensity reversal

In this case, industries are not consistent

in their factor intensities. Let one industry

represent gravel and the second representfurniture.

Gravel is labour intensive at low

wage/rental ratios and capital intensive at

high wage/rental ratios, both intensitiesare measured relative to furniture.


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Labour

Capital

.

.Gravel

KG

KG

The isoquant for gravel is very flat,

showing a great change in K/L as

w/r changes.

(Extreme case is straight line)

LG

LG


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Labour

Capital

.

.

Furniture

KF

KF

The isoquant for furniture is very

curved, showing that K/L doesnt

change a lot when w/r changes.

(Extreme case is L-shaped isoquant).

LFLF


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Labour

Capital

..

.

.

Furniture

Gravel

KG

KF

KF

KG

Gravel uses a higher K/L relative to

furniture at high w/r,

Gravel uses a lower K/L relative to

furniture at low w/r

LG LFLF

LG


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Labour

Capital

..

.

.

(w/r)1

(w/r)2

Furniture

Gravel

KG2

KF2

KF

1

KG1

Gravel uses a higher K/L relative to

furniture at high w/r,

Gravel uses a lower K/L relative to

furniture at low w/r

LG2

LF2 LF

1 LG1


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Factor Intensity Reversal

When these countries trade, the capital intensive

industry in one country can be the labour

intensive industry in the other.

If country 1 is labour abundant, we might expect it to

export gravel, since at low levels of w/r, gravel is

labour intensive.

However, If country 2 is capital abundant, we might ALSO

expect it to export gravel, since at high w/r, gravel is

capital intensive.


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Factor Intensity Reversal

with factor intensity reversals, we cannot

predict the pattern of trade.

Therefore

we cannot predict the effect of trade on factor

demands in a country

we cannot predict the effect of trade onincomes of factors.


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Monopoly

Any kind of imperfect competition canlower the predictive power of the H-Omodel.

Monopoly is one special case thatdeserves its own analysis.

If an industry is a monopoly, neo-

classical trade theory predicts thattrade can sometimes be harmful to thecountries trading.


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Monopoly and trade

There are different scenarios for monopoly andtrade

1.M

onopoly can be maintained within a country,but the monopoly can export outside the

country (not great for country)

2. Monopoly becomes open to competition when

the country opens to trade.3. Monopoly becomes world monopoly with trade

(not great for anyone except monopoly).


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Monopoly and trade

There are different scenarios for monopoly andtrade

1. Monopoly can be maintained within a country,

but the monopoly can export outside thecountry (not great for country)

2. Monopoly becomes open to competition whenthe country opens to trade.

3. Monopoly becomes world monopoly with trade(not great for anyone except monopoly).

1. Monopoly joins other country monopolies to becomea cartel.


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Monopoly - review

Market condition for monopoly

Monopoly faces a market demand curve,

price falls as monopoly increases supply tothe market.

Monopoly marginal revenue is NOT equal toprice, it falls as monopoly supplies moregoods to market.

The marginal cost curve is NOT a supplycurve for the monopoly. There is no supplycurve for a monopoly.


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Monopoly - review

Monopoly behaviour

Quantity supplied

monopoly chooses the quantity to supply

based on the marginal cost (MC) andmarginal revenue (MR).

At MC = MR, with marginal cost rising,monopoly will pay more to produce an extra

unit of output than it will earn in the marketfrom selling it.

Monopoly therefore supplies the quantitydetermined by MR=MC


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Monopoly - review

Monopoly behaviour

Price charged

Monopoly charges the highest price it canget away with!

With a market demand curve the price is

determined by the demand curve at the

quantity supplied by the monopoly.


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Monopoly in countryPrice

Quantity

Demand curveMarginal

revenue

MC

P0

Q0


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Monopoly - trade

Monopoly market conditions

If the monopoly can maintain a monopoly

ath

ome and trade freely on theotherwise competitive internationalmarket

then it faces 2 different demand curves

1. the downward sloping home demand2. a flat (MR = Pint) world demand,

reflecting a competitive world market.


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Monopoly - trade

Monopoly market conditions

Monopoly marginal revenue

with TWO markets

home monopoly, and

a competitive international market

MR is downward sloping until it hits the

world price, then it is a flat line at the worldprice.


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Quantity

Demand curve

Marginal

revenue

MC

P0

Q0

PInt


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Monopoly - trade

M

onop

oly behaviour Monopoly chooses output produced based

on MC= MR (Q1)

Monopoly separates supply into two

markets it chooses supply in each market to maximize

profits.

Home market: it will supply at point where MR

home = MR international (kink). (Q2) note, below that point, monopolist makes less money

selling at home than it does selling exports

It sells the rest on the world market (Q1 Q2)


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Quantity

Demand curve

Marginal

revenue

MC

P0

Q0

PInt

Q2 Q1


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Monopoly - trade

Monopoly behaviour

Price charged by monopoly

Monopoly charges the highest price it can get

away with in each market At home, it charges P2 which is determined

by the home demand curve

Internationally, it charges Pint

which is

determined by the international market.


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Quantity

Demand curve

Marginal

revenue

MC

P0

Q0

PInt

Q2 Q1

P2


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Monopoly - trade

Case

2.M

onopoly with open markets If markets are opened internally and the

monopoly can trade freely on the world

market,and, if

world markets are competitive

then monopoly loses monopoly power and

starts to act like a competitive firm.


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Monopoly - trade

Case 3.

Monopoly with internationalmonopoly power

When a countrys monopoly because an

international monopoly, if it is possible, it will price discriminate

between markets.

(if price discrimination is not possible,then the monopoly will act like a single

country monopoly its country is the

world)


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Monopoly - trade

Price discrimination:

Price discrimination occurs when a firm sells the

same good to different markets at different

prices. Therefore, one market is paying a lowerprice for the same good than another market.

Price discrimination can only occur when a

monopoly can separate its markets.

That is, it must be able to sell to one market

(lower price market) and not have the buyers in

that market resell to the higher price market.


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Monopoly - trade

Price discrimination:

If a monopoly can price discriminate, it will sell an

amount and charge a price that maximizes the

monopolists profits in each market.Therefore, if it can charge a higher price in one

market than it can in another, it will.

The higher price will be based on the elasticity of

demand. This will be based on the slope of the

demand curve, and the income in the country

(height of demand curve).


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Monopoly - trade

Price discrimination, monopolybehaviour:

In each market, the monopoly determines the amount to supply based

on MR=MC (profit maximizing amount to

supply)

charges the highest price that it can

(which is constrained by the demand

curve)


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Price discriminating monopolist

with constant MC

PP

QuantityQuantity

MCMC

PII

PI

QIQII

Country I

Country II


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Summary

Monopoly trade models show that exposing monopolies to international competition makes

them behave like firms in a competitive market and lowers

price and increases output at home.

letting monopolies export while maintaining the homemarket can raise price and lower quantity supplied at

home.

letting monopolies have international monopoly power

promotes price discrimination, which will lead to higherprices in richer countries or in countries with less elastic

demand as compared to poor countries or countries with

elastic demand.

international economics -some violations of h-o assumptions

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